Sitting at below $2, Rite Aid Corporation (NYSE:RAD) stock looks cheap. Even with RAD stock news that seems to get only worse, investors no doubt are asking, “Should I buy Rite Aid stock?”
The answer, unfortunately, is no. There are reasons to think RAD stock is a buy. The sale of over 40% of the company’s stores to Walgreens Boots Alliance Inc (NASDAQ:WBA) finally has been approved. As Lawrence Meyers pointed out, the per-store value in the Walgreens deal suggests a $4+ per share valuation for RAD stock. Dana Blankenhorn floated the idea of the remaining stores being acquired by Amazon.com, Inc. (NASDAQ:AMZN), whose pharmacy ambitions are no secret.
The balance sheet is much-improved going forward, and interest expense will come down markedly. And at this point, the RAD stock news can only get better, after a nearly 80% decline in RAD stock so far this year.
But if you look closer, the bull case for Rite Aid falls apart. Revenue is falling, and earnings are tumbling faster, a huge problem given the still-significant leverage the company will have after the Walgreens sale is complete. The net proceeds from the sale are smaller than headline numbers suggest. And the EnvisionRx PBM (pharmacy benefit management) business almost certainly isn’t worth what Rite Aid paid for it.
When you run the numbers to that level of detail, the fundamental case for RAD suddenly looks much, much weaker. Combine that with slowing growth and industry challenges, and RAD stock simply is not worth chasing, not even at current levels.
The Asset Case for RAD Stock
The easy math for RAD stock shows big upside. Walgreens is paying $4.375 billion for 1,932 stores. That suggests a per-store valuation of $2.26 million per store. Rite Aid will keep 2,575 stores, plus its EnvisionRx business. And so:
- 2,575 stores at $2.26 million = $5.82 billion in store valuation
- The company paid $2.1 billion for EnvisionRx
- Rite Aid is getting $4.375 billion in cash from WBA (note that the $325-million merger termination fee was received in Q2)
- Rite Aid had $6.9 billion in net debt at the end of Q2, per the Q2 conference call
Add it up, and Rite Aid should be worth about $5.4 billion, or in the range of $5 per share. Instead, it’s valued at about $2 billion, which is less than $2 per share.
The Problems for RAD Stock
There’s a couple holes here already, however. For one, the per-store valuation in a takeout scenario isn’t necessarily ongoing fair value for the stores. Notably, Rite Aid stores have had a horrid first half of FY18 (more on that in a moment), which in theory should have depressed that valuation since the revised deal was just agreed to. In addition, there isn’t another bidder on the horizon. It’s not as if CVS Health Corp (NYSE:CVS) is likely to step in and buy the other 2,575 stores. What Walgreens paid on a per-store basis is almost certainly higher than what those stores are worth right now in the market. Assuming even a 20% haircut takes $1 per share off RAD’s fair value.
Problem two is EnvisionRx. Yes, Rite Aid paid $2.1 billion in 2015. But the PBM space has changed markedly. The largest PBM in the United States is Express Scripts Holding Company (NASDAQ:ESRX). Its stock has declined 31% since Rite Aid agreed to acquire EnvisionRx. That in turn suggests that EnvisionRx is worth closer to $1.5 billion, even assuming Rite Aid didn’t overpay, taking about $0.60 per share off RAD’s fair value in this model.
Problem three is that the company isn’t getting $4.375 billion. Per the Q2 earnings presentation, there are $445 million of associated costs, including accrued liabilities, restructuring charges, and income tax expense. That takes another $0.40 off our model. Suddenly, RAD stock looks like it’s worth closer to $3.
Is More Bad RAD Stock News on the Way?
Admittedly, $3 still looks attractive against a current price of around $1.80. But there’s still the problem that profits are falling quickly. Adjusted EBITDA declined by roughly one-third in both Q1 and Q2. And looking at pro forma figures, RAD doesn’t look that cheap as a going concern.
Net debt at the end of Q2 was $6.9 billion. That should drop about $3.9 billion, with cash from Walgreens used to pay off debt, putting the pro forma figure at about $3 billion. The market cap is just under $2 billion, putting the enterprise value of RAD stock at just under $5 billion.
Trailing 12-month adjusted EBITDA is $674 million, implying an EV/EBITDA multiple over 7x. That’s not an attractive multiple, particularly with profits declining. And the leverage ratio (debt to EBITDA) still sits over 4x, a high-risk figure.
What the current price of RAD stock suggests is that either a) Rite Aid will sell the rest of its stores relatively soon, or b) the current profit declines will end in the next couple of quarters. Neither is guaranteed, or even likely.
At the end of the day, there’s a reason that RAD stock continues to decline. It’s not short sellers, and it’s not manipulation. It’s that Rite Aid sales and earnings are declining, and a rescuer doesn’t seem to be on the horizon. Understanding the math and the trends here, it’s not hard to see why. I didn’t like RAD stock at $4, and I don’t like it below $2. This can get worse.
As of this writing, Vince Martin has no positions in any securities mentioned.
